U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A-1
(Mark One)
[x] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of
1934 for the quarterly period ended December 31, 2005.
[ ] Transition report pursuant to Section 13 or 15(d) of the Exchange act for
the transition period from
to
- ------------------------------- ------------------------------------------
Commission File Number: 1-15695
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Avitar, Inc.
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(Exact name of small business issuer as specified in its charter)
Delaware 06-1174053
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
65 Dan Road, Canton, Massachusetts 02021
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(Address of principal executive offices) (Zip Code)
(781) 821-2440
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(Issuer's telephone number)
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. [x]Yes [ ]No
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
COMMON STOCK: 220,662,935
AS OF FEBRUARY 10, 2006
Transitional Small Business Disclosure Format
(Check One): [ ] Yes ; [x] No
Transitional Small Business Disclosure Format
(Check One): [ ] Yes ; [x] No
Page 1 of 25 pages
Exhibit Index is on Page 21
TABLE OF CONTENTS
Page
PART I: FINANCIAL INFORMATION 3
Item 1 Consolidated Financial Statements
Balance Sheet 4
Statements of Operations 5
Statement of Stockholders' Deficit 6
Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8
Item 2 Management's Discussion and Analysis or Plan of Operation 15
Item 3 Controls and Procedures 17
PART II: OTHER INFORMATION 18
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 19
SIGNATURES 20
EXHIBIT INDEX 21
CERTIFICATIONS 22
PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Avitar, Inc. and Subsidiaries
Consolidated Balance Sheet
December 31, 2005
(Unaudited)
- ------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 55,587
Accounts receivable 483,504
Inventories 636,781
Prepaid expenses and other 117,692
------------
Total current assets 1,293,564
PROPERTY AND EQUIPMENT, net 317,040
GOODWILL, net 138,120
OTHER ASSETS 512,823
------------
Total $ 2,261,547
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Notes payable (Note 5) $ 141,076
Convertible notes payable (Note 5) $ 632,937
Accounts payable 613,892
Accrued expenses 776,703
Deferred revenue 16,150
Current portion of long-term capital leases 15,213
Current portion of deferred lessor incentive 13,400
Fair value of warrants (Note 11) 59,468
Fair value of embedded drivatives (Note 11) 799,450
------------
Total current liabilities 3,068,289
------------
LONG-TERM DEBT, LESS CURRENT PORTION 1,433,452
LONG-TERM CAPITAL LEASES, LESS CURRENT PORTION 11,018
DEFERRED LESSOR INCENTIVE, LESS CURRENT PORTION 46,900
------------
Total Liabilities 4,559,659
CONVERTIBLE AND REDEEMABLE CONVERTIBLE PREFERRED
STOCK (Note 6) 2,970,649
COMMITMENTS
STOCKHOLDERS' DEFICIT
Series B convertible preferred stock, $.01 par value;
authorized 5,000,000 shares; 5,689 shares issued and
outstanding 58
Common Stock, $.01 par value; authorized 300,000,000 shares;
216,117,480 shares issued and outstanding 2,161,174
Additional paid-in capital 46,971,877
Accumulated deficit (54,401,870)
------------
Total stockholders' deficit (5,268,761)
------------
Total $ 2,261,547
============
See accompanying notes to consolidated financial statements.
Avitar, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
THREE MONTHS ENDED DECEMBER 31,
-------------------------------
2005 2004
------ ------
SALES $ 907,270 $ 1,036,040
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OPERATING EXPENSES
Cost of sales 658,993 716,009
Selling, general and administrative 1,038,607 932,662
Research and development 129,706 196,443
------------- -------------
Total operating expenses 1,827,306 1,845,114
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LOSS FROM OPERATIONS (920,036) (809,074)
------------- -------------
OTHER INCOME (EXPENSE)
Interest expense and financing costs (213,235) (13,186)
Other income (expense), net 121,342 (520,630)
------------- -------------
Total other expense, net (91,893) (533,816)
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LOSS FROM CONTINUING OPERATIONS (1,011,929) (1,342,890)
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DISCONTINUED OPERATIONS:
Income from the disposal of USDTL (Note 3) 120,000 -
------------- -------------
Income from discontinued operations 120,000 -
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NET LOSS $ (891,929) $ (1,342,890)
============= =============
BASIC AND DILUTED LOSS PER SHARE FROM CONTINUING
OPERATIONS (Note 9) $ (0.01) $ (0.01)
============= =============
BASIC AND DILUTED NET LOSS PER SHARE (Note 9): $ (0.01) $ (0.01)
============= =============
WEIGHTED AVERAGE
NUMBER OF COMMON SHARES OUTSTANDING 202,270,171 130,174,135
============= =============
See accompanying notes to consolidated financial statements.
Avitar, Inc. and Subsidiaries
Consolidated Statement of Stockholders' Deficit
Three Months Ended December 31, 2005
(Unaudited)
Preferred Stock Common Stock Total
................ .................... Additional Accumulated Stockholders'
Shares Amount Shares Amount paid-in capital deficit Deficit
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2005 5,689 $ 58 190,659,39 $1,906,59 $46,992,19 ($53,504,524) $(4,605,677)
Conversion of Series E preferred stock - - 25,458,087 254,580 (20,318) - 234,262
Payment of convertible preferred stock
dividend for Series A preferred stock - - - - - (5,417) (5,417)
Net loss - - - - - (891,929) (891,929)
- ----------------------------------------------- ---- ----------- --------- ---------- ------------ -------------
Balance at December 31, 2005 5,689 $58 216,117,480 $2,161,174 $46,971,877 ($54,401,870 ($5,268,761)
=============================================== ==== =========== ========= ========== ============ =============
See accompanying notes to consolidated financial statements.
Avitar, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
THREE MONTHS ENDED DECEMBER 31,
--------------------------------
2005 2004
--------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 891,929) ($1,342,890)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 43,666 39,669
Amortization of debt discount and deferred financing 152,114 -
Amortization of deferred rent expense - 31,192
Amortization of deferred lessor incentive 3,350 -
(Income) expense from change in value of derivatives
and warrants (120,116) 521,067
Changes in operating assets and liabilities:
Accounts receivable 94,627 146,823
Inventories (261,865) (152,278)
Prepaid expenses and other current assets 85,690 29,520
Other assets (4,737) (201)
Accounts payable and accrued expenses (16,959) (231,448)
Net cash used in operating activities (916,159) (958,546)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (51,496) (20,482)
----------- -----------
Net cash used in investing activities (51,496) (20,482)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (141,704) (63,272)
Sale of preferred stock and warrants - 1,159,775
Net proceeds from issuance of convertible long-term debt 920,000
Redemption of Series A redeemable convertible
preferred stock (150,000)
Payment of cash dividend on Series A redeemable
convertible prefered stock (5,417) -
--------------- --------------
Net cash provided by financing activities 622,879 1,096,503
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (344,776) 117,475
CASH AND CASH EQUIVALENTS, beginning of the period 400,363 508,876
--------------- --------------
CASH AND CASH EQUIVALENTS, end of the period $55,587 $626,351
=============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during period:
Income taxes $ - $ -
Interest $ 18,484 $ 8,291
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
During the three months ended December 31, 2005, 224,712 shares of
Series E redeemable convertible preferred stock were converted into
25,458,087 shares of common stock.
During the three months ended December 31, 2004, 958 shares of
Series A redeemable convertible preferred stock were converted into
13,205,882 shares of common stock.
During the three months ended December 31, 2004, 250 shares of
Series A convertible preferred stock were converted into
2,520,251 shares of common stock.
During the three months ended December 31, 2004, 311,500 shares of
common were issued as payment of dividends for Series A
convertible and redeemable convertible preferred stock.
See accompanying notes to consolidated financial statements.
AVITAR, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
================================================================================
1. BASIS OF PRESENTATION
Avitar, Inc. (the "Company" or "Avitar") through its wholly-owned
subsidiary Avitar Technologies, Inc. ("ATI") develops, manufactures,
markets and sells diagnostic test products and proprietary hydrophilic
polyurethane foam disposables fabricated for medical, diagnostics, dental
and consumer use. During the first quarter of FY2006, the Company continued
the development and marketing of innovative point of care oral fluid drugs
of abuse tests, which use the Company's foam as the means for collecting
the oral fluid sample. Through its wholly owned subsidiary, BJR Security,
Inc. (`BJR"), the Company provides specialized contraband detection and
education services.
In December 2003, the Company sold the business and net assets,
excluding cash, of its wholly owned subsidiary, United States Drug Testing
Laboratories, Inc. ("USDTL") which operated a certified laboratory and
provided specialized drug testing services primarily utilizing hair and
meconium as the samples. In November 2005, the Company negotiated an
agreement with the new owners of USDTL to settle all outstanding matters
related to the sale of USDTL (see Note 3). Therefore, USDTL is considered a
discontinued operation and this report reflects the continued operations of
the Company. Due to the current financial condition at Avitar, the Company
may consider selling assets and/or operations, including BJR. However, at
the present time, there can be no assurances that the Company would be
successful in these efforts.
During the audit for Fiscal 2005, the Company was advised by its
independent registered public accounting firm that the method used to
account for sales of certain convertible preferred stock and convertible
notes was not in accordance with the requirements of Emerging Issues Task
Force ("EITF") Issue No. 00-19 "Accounting for Derivative Financial
Instruments Indexed To and Potentially Settled In, a Company's Own Stock".
As a result, management determined that certain previously issued financial
statements should not be relied upon. The consolidated financial statements
included herein reflect the correct method to account for the issuance of
various securities and the derivative features embedded therein.
The accompanying consolidated financial statements of the Company have
been prepared in accordance with generally accepted accounting principles
for interim financial information, the instructions to Form 10-QSB and
Regulation S-B (including Item 310(b) thereof). Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
the Company's management, all adjustments (consisting only of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three-month period ended December 31,
2005 are not necessarily indicative of the results that may be expected for
the full fiscal year ending September 30, 2006. The accompanying
consolidated financial statements should be read in conjunction with the
audited financial statements of the Company for the fiscal year ended
September 30, 2005. The Company's consolidated financial statements have
been presented on the basis that it is a going concern, which contemplates
the realization of assets and the satisfaction of liabilities in the normal
course of business. The Company has suffered recurring losses from
operations and has a stockholders' deficit as of December 31, 2005 of
$5,268,761. The Company raised net proceeds aggregating approximately
$2,498,000 during the year ended September 30, 2005 from the sale of stock
and warrants. In addition, the Company raised gross proceeds of $900,000
from short-term convertible notes and $1,000,000 from long-term convertible
notes. During October 2005, the Company raised gross proceeds of $1,000,000
from long-term convertible notes and received $120,000 from the settlement
agreement related to the sale of USDTL described above and in Note 3. The
Company is working with placement agents and investment fund mangers to
obtain additional equity financing. Based upon cash flow projections, the
Company believes the anticipated cash flow from operations and most
importantly, the expected net proceeds from future equity financings will
be sufficient to finance the Company's operating needs until the operations
achieve profitability. There can be no assurances that forecasted results
will be achieved or that additional financing will be obtained. The
financial statements do not include any adjustments relating to the
recoverability and classification of asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
2. INVENTORIES
At December 31, 2005, inventories consist of the following:
Raw Materials $386,351
Work-in-Process 102,295
Finished Goods 148,135
Total $636,781
3. DISCONTINUED OPERATIONS
On December 16, 2003, the Company consummated a sale of USDTL's
business and net assets, excluding cash. Under the terms of that sale, the
buyer must pay the Company 10% of certain annual revenues in excess of
$1,500,000, less any amounts due from the Company for the purchase of
services from the buyer. In November 2005, the Company negotiated an
agreement with the new owners of USDTL to settle all outstanding matters
related to the sale of USDTL. Under the terms of this settlement, the
Company received an immediate lump sum payment of $120,000 rather than
waiting for the 10 to 14 years that the Company believed it would take to
collect the entire $500,000 from uncertain future revenues of USDTL. The
accompanying financial statements reflect USDTL as a discontinued
operation. The following is a summary of the results of its operations for
the three months ended December 31, 2005 and 2004:
Three months ended December 31, 2005 2004
--------------------------------------------------------------------
Sales $ - $ -
Operating expenses - -
Other income (expense) 120,000 -
--------------------------------------------------------------------
Income from discontinued operations $ 120,000 $ -
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4. MAJOR CUSTOMERS
Customers in excess of 10% of total sales are:
Three Months Ended December 31,
-------------------------------------
2005 2004
Customer A $ 222,830 $ 253,786
Customer B * 222,200
*Customer was not in excess of 10% of total sales.
At December 31, 2005, accounts receivable from major customers totaled
approximately $98,000.
5. NOTES PAYABLE AND SHORT AND LONG-TERM CONVERTIBLE NOTES PAYABLE
In September and October 2005, the Company executed notes payable with
AJW Partners, LLC, AJW Offshore, Ltd., AJW Qualified Partners, LLC and New
Millennium Capital Partners II, LLC in the total principal amount of
$2,000,000 which is payable at maturity in September and October 2008.
Interest on these notes is 8% and is payable quarterly in cash or the
Company's common stock at the option of the Company. The Company issued
warrants to purchase 4,000,000 shares of common stock at $.25 per share for
five years in connection with these notes. In addition, the entire
principal plus any accrued and unpaid interest associated with these notes
is convertible, at the holder's option, into the Company's common stock at
a conversion price of 65% of the average of the three lowest intraday
trading prices of the common stock for the twenty trading days preceding
the date that the holders elect to convert. A discount to debt totaling
$616,800 ($567,000 for the fair value of the conversion feature of these
notes and $49,800 for the fair value of the warrants issued in connection
with these notes) was recorded during FY2005 and the first quarter of
FY2006 and is being amortized over the term of the notes. The unamortized
discount was $566,548 as of December 31, 2005. Fees of approximately
$290,000 incurred in connection with securing these loans were recorded as
a deferred financing charge. The collateral pledged by the Company to
secure these notes includes all assets of the Company. A liability of
approximately $617,000 was recorded for the fair value of the warrants
issued in connection with the $2,000,000 of notes and the conversion
feature which was increased to its market value of approximately $650,000
at December 31, 2005.
From April to August 2005, the Company executed convertible notes with
an individual in the total principal amount of $650,000 with interest at
10%. Each note has a maturity date of six months from the date of the note
and is payable in ten monthly installments plus accrued interest commencing
on the maturity date of the note. The Company issued warrants to purchase
650,000 shares of common stock at $.033 to $.099 per share for three (3)
years in connection with these notes. In addition, the entire principal
plus accrued interest associated with these notes is convertible into the
Company's common stock at a conversion price of the lesser of the closing
price of the common stock on the date of the loan or 85% of the average
closing price of the common stock for the five (5) trading days preceding
the notice of conversion. In no event shall the conversion price be lower
than 50% of the closing price of the common stock on the date of the loan.
A discount to debt totaling $172,930 ($156,800 for the value of the
conversion feature of these notes and $16,130 for the value of the warrants
issued in connection with these notes) was recorded during FY2005 and is
being amortized over the term of the notes. The unamortized discount was
$17,063 as of December 31, 2005. A liability of approximately $173,000 was
recorded for the fair value of the warrants issued in connection with the
$650,000 of notes and the conversion feature which was reduced to its
market value of $4,045 at December 31, 2005.
6. CONVERTIBLE AND REDEEMABLE CONVERTIBLE PREFERRED STOCK
In the April and June 2005, the Company raised net proceeds of
approximately $1,335,000 from the sale of 1,500,000 shares of Series E
Redeemable Convertible Preferred Stock with a face value of $1,500,000 and
Warrants to purchase 150,000 shares of the Company's common stock. The
$1,500,000 of Series E Preferred Stock are convertible into Common Stock at
the lesser of $.08 per share or 80% of the average of the three lowest
closing bid prices for the ten trading days immediately prior to the notice
of conversion, subject to adjustments and limitations, and the Warrants are
exercisable at $.084 per share for a period of three years. The warrants
issued in connection with the sale of 1,500,000 shares of preferred stock
and the conversion feature resulted in a deemed dividend of $1,087,000
being recorded and included in the earnings per share calculation for the
year ended September 30, 2005. A liability of approximately $1,087,000 was
recorded for the original fair value of the warrants issued in connection
with the sale of the 1,500,000 shares of preferred stock and the conversion
feature which was reduced to its market value of approximately $165,000 at
December 31, 2005. As of December 31, 2005, 724,351 shares of this
preferred stock had been converted into 36,777,767 shares of common stock
and 775,649 were outstanding. Upon the occurrence of specific events, the
holders of the Series E Redeemable Convertible Preferred Stock are entitled
to redeem these shares under certain provisions of the agreement covering
the purchase of the preferred stock. Accordingly, this security was not
classified as permanent equity.
In December 2004, the Company sold 1,285 shares of Series A Redeemable
Convertible Preferred Stock and Warrants to purchase 600,000 shares of
common stock for which it received net proceeds of approximately
$1,160,000. The Series A Redeemable Convertible Preferred Stock, with a
face value of $1,285,000, is convertible into common stock at the lesser of
$.12 per share or 85% of the average of the three lowest closing bid
prices, as reported by Bloomberg, for the ten trading days immediately
prior to the notice of conversion subject to adjustments and floor prices.
The Warrants are exercisable at $.126 per share. The warrants issued in
connection with the sale of 1,285 shares of preferred stock and the put
right and the conversion feature resulted in a deemed dividend of
$1,058,260 being recorded and included in the earnings per share
calculation for the year ended September 30, 2005. A liability of
approximately $1,058,260 was recorded for the original fair value of the
warrants issued in connection with the sale of the 1,285 shares of
preferred stock and the conversion feature which was $3,000 at December 31,
2005. As of December 31, 2005, 1,135 shares of this preferred stock had
been converted into 22,607,777 shares of common stock and the remaining 150
shares of Series A redeemable convertible preferred stock, with a face
value of $150,000, were redeemed by the Company in October 2005 for
$155,415 which included accrued dividends of $5,417.
36,941 shares of the Series C convertible preferred stock with a face
value of $195,000 and 2,000 shares of the 6% Convertible preferred stock
with a face value of $2,000,000 are carried at face value on the balance
sheet outside permanent equity as the Company cannot be sure it has
adequate authorized shares for their conversion as of December 31, 2005.
7. COMMON AND PREFERRED STOCK
During the quarter ended December 31, 2005, the Company issued
25,458,087 shares of common stock to holders who converted 224,351 shares
of Series E redeemable convertible preferred stock. Dividends for all
preferred stock amounted to $42,435 for the three months ended December 31,
2005 and the total amount of unpaid and undeclared dividends was $284,321.
8. GOODWILL
As of September 30, 2005, the Company's goodwill was composed of
$138,120 associated with the acquisition of BJR in 2001. In accordance with
SFAS No. 142, the Company evaluated the goodwill related to the BJR
acquisition and determined that no adjustment to the goodwill balance of
$138,120 was deemed necessary since September 30, 2005.
9. LOSS PER SHARE
The following data show the amounts used in computing earnings per share:
Three Months Ended December 31, 2005 2004
--------------------------------------------------------------------------------------
Loss from continuing operations $ (1,011,929) $(1,342,890)
Less:
Deemed dividends in connection with
Series A preferred stock sales (-) (1,058,260)
Preferred stock dividends (42,435) (50,264)
------------ -----------
Loss attributable to common stockholders
from continuing operations (1,054,364) (2,451,414)
Add:
Income from discontinued operations 120,000 (-)
------------ -----------
Net loss attributable to common
stockholders used in basic and
diluted EPS $ (934,364) $(2,451,414)
============ ===========
Weighted average number of
common shares outstanding 202,270,171 130,174,135
------------ ------------
Loss per share attributable to common
stockholders before discontinued
operations $(0.01) $(0.01)
Impact of discontinued operations - -
------- -------
Basic and diluted loss per share
attributable to common stockholders $(0.01) $(0.01)
======= =======
10. STOCK OPTIONS
The Company accounts for its stock-based compensation plans using the
intrinsic value method in accordance with the provisions of APB Opinion No.
25, Accounting for Stock Issued to Employees, and complies with the
disclosure provisions of SFAS No. 123, Accounting for Stock- Based
Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation-
Transition and Disclosure. No stock-based employee compensation cost was
reflected in net loss for the quarters ended December 31, 2004 or 2003, as
all options granted under those plans had an exercise price equal to the
fair market value of the underlying common stock on the date of grant.
The following table illustrates, in accordance with the provisions of SFAS No.
148, Accounting for Stock-Based Compensation - Transition and Disclosure, the
effect on net loss and loss per share if the Company had applied the fair value
recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation.
For the Three Months Ended December 31, 2005 2004
Net loss $(891,929) $(1,342,890)
Add: stock based employee compensation
expense included in reported net loss,
net of tax - -
Deduct: total stock based employee
compensation expense determined
under the fair value based method for
all awards, net of tax (30,595) (32,395)
--------- -----------
Pro forma net loss $(922,524) $(1,375,285)
========= ===========
Pro forma loss per share:
Basic and diluted - as reported $(.01) $(.01)
Basic and diluted - pro forma (.01) (.01)
In determining the pro forma amounts above, the Company estimated the fair value
of each option granted using the Black-Scholes option pricing model with the
following weighted-average assumptions:
December 31 2005 2004
Risk free interest rate 4.0% 3.8%
Expected dividend yield - -
Expected lives 5-9 years 5-9 years
Expected volatility 80% 80%
No options were granted during the quarter ended December 31, 2005 while the
options granted for the three months ended December 31, 2004 amounted to
1,663,700. The weighted average fair value of options granted during the three
months ended December 31, 2004 was $0.07.
11. DERIVATIVES
The Company has issued and outstanding convertible debt and certain
convertible equity instruments with embedded derivative features. The
Company analyzes these financial instruments in accordance with SFAS No.
133 and EITF Issue Nos. 00-19 and 05-02 to determine if these hybrid
contracts have embedded derivatives which must be bifurcated. In addition,
free-standing warrants are accounted for as equity or liabilities in
accordance with the provisions of EITF Issue No. 00-19. As of December 31,
2005, the Company could not be sure it had adequate authorized shares for
the conversion of all outstanding instruments due to certain conversion
rates which vary with the fair value of the Company's common stock and
therefore all embedded derivatives and freestanding warrants are recorded
at fair value, marked-to-market at each reporting period, and are carried
on separate lines of the accompanying balance sheet. If there is more than
one embedded derivative, their value is considered in the aggregate.
12. SUBSEQUENT EVENTS
Since December 31, 2005, holders of Series C convertible preferred
stock converted 8,333 shares of preferred stock with a face value of
$50,000 into 4,545,455 shares of common stock. Also since December 31,
2005, the Company filed a Certificate of Amendment of its Certificate of
Incorporation that at 5 P.M. (Delaware Time) on February 17, 2006 will
effect a one-for-fifty (1 for 50) reverse stock split of the Company's
outstanding common stock. When the reverse stock split becomes effective,
each outstanding fifty shares of common stock will be combined into and
become one share of common stock.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion and analysis should be read in conjunction with
the Company's consolidated financial statements and the notes thereto appearing
elsewhere in this report.
RESULTS OF OPERATIONS
Revenues
Sales for the three months ended December 31, 2005 decreased $128,770 or
approximately 12 %, to $907,270 from $1,036,040 for the corresponding period of
the prior year. The change for the three months ended December 31, 2005
primarily reflects decrease in volume of sales of $138,000 for its OralScreen(R)
products and $5,000 for its Foam Products, offset in part by an increase of
$14,000 in revenue from contraband detection services.
Operating Expenses
Cost of sales for the three months ended December 31, 2005 were
approximately 73% of sales compared to the cost of sales of approximately 69% of
sales for the three months ended December 31, 2004. The change for the first
quarter of Fiscal 2006 resulted from the reduction in sales described above and
a shift in the product mix to the lower margin foam products which accounted for
49% of revenue in Fiscal 2006 versus 44% in Fiscal 2005.
Selling, general and administrative expenses for the three months ended
December 31, 2005 increased $105,945, or approximately 11%, to $1,038,607 from
$932,662 for the corresponding period of the prior year. The change for the
three-month period ended December 31, 2005 primarily resulted from an increase
of approximately $80,000 for the addition of sales and marketing resources. In
order to achieve revenue growth, the Company will continue to incur increased
expenses to hire additional direct sales staff and expand marketing programs
during the remainder of FY2006 and beyond.
Research and development expenses for the three months ended December 31,
2005 amounted to $129,706 compared to $196,443 for the three months ended
December 31, 2004. The decrease for the quarter ended December 31, 2005 was
primarily attributable to lower consulting expense. Although research and
development expense were lower for the first quarter of Fiscal 2006, the Company
must continue developing and enhancing its ORALscreen products and therefore,
will most likely incur increased expenses for research and development during
the remainder of FY2006 and beyond.
Other Income and Expense
Interest expense and financing costs were $213,235 for the three months
ended December 31, 2005 compared to $13,186 incurred during the three months
ended December 31, 2004. The increase resulted primarily from interest expense
of approximately $50,000 and amortization of deferred financing costs and debt
discount of approximately $152,000 associated with the short-term notes and
convertible short and long-term notes totaling approximately $2,900,000 that
were executed by the Company in FY2005 and the first quarter of FY2006.
For the three months ended December 31, 2005, other income amounted to
$121,342 compared to other expense of $520,630 for the three months ended
December 31, 2004. The change for the quarter ended December 31, 2005 resulted
primarily from changes in the fair market value of derivative securities and
warrants.
Discontinued Operations
On December 16, 2003, the Company consummated the sale of the business and
net assets, excluding cash, of its USDTL subsidiary. For the three months ended
December 31, 2005, other income amounted to $120,000 compared to no activity for
the corresponding period of the prior year. The income for the quarter ended
December 31, 2005 resulted from the settlement described in Note 3 of the
Consolidated Financial Statements.
Net Loss
Primarily as a result of the factors described above, the Company had a net
loss of $891,929 for the three months ended December 31, 2005, as compared to
net loss of $1,342,890 for the three months ended December 31, 2004. The loss
per share was $.01 per basic and diluted share for the three months ended
December 31, 2005. The loss per share was $.01 per basic and diluted share for
the three months ended December 31, 2004.
FINANCIAL CONDITION AND LIQUIDITY
At December 31, 2005, the Company had a stockholders'deficit of $5,268,761
and cash and cash equivalents of $55,587. Our cash flows from financing
activities provided the primary source of funding during the quarter ended
December 31, 2005 and the Company will continue to rely on this type of funding
until profitability is reached. The following is a summary of cash flows for the
three month period ended December 31, 2005:
December 31,
Sources (use) of cash flows 2005
-----------------------------------------------------------
Operating activities $ (916,159)
Investing activities (51,496)
Financing activities 622,879
Net decrease in cash and equivalents $ (344,776)
Operating Activities. The net loss of $891,929 (comprised of expenses
totaling $1,919,199 less revenues and income from discontinued
operations of $1,027,270) was the major use of cash by operations.
When the net loss is adjusted for non-cash expenses such as
depreciation and amortization, amortization of debt discounts,
deferred financing costs, deferred rent and income from the changes in
the fair market value of derivative securities and warrants, the cash
needed to finance the net loss was $812,915. Working capital
requirements necessitated the use of $16,959 to pay aging accounts
payable and reduce accrued expenses and $261,865 to increase inventory
levels to meet anticipated demand for our products during the next six
months. A decrease in accounts receivable of $94,627 due to the lower
billings for ORALscreen products during the quarter and decreases in
prepaid expenses and other current assets of $85,690 lessened working
capital needs by $180,317. The addition of $4,737 of other assets
further increased the operating cash needs.
Investing and Financing Activities. Cash used in investing consisted
of cash paid of $51,496 for additions to property, plant and
equipment. To finance the business, long-term notes (as described
below) were executed and approximated $920,000; of which $141,704 was
used to repay various short and long-term debt and $155,417 was used
to redeem remaining shares of the Series A redeemable convertible
preferred stock and the accrued dividends for these shares. .
During FY 2006, the Company's cash requirements are expected to include
primarily the funding of operating losses, the payment of outstanding accounts
payable, the repayment of certain notes payable, the funding of operating
capital to grow the Company's drugs of abuse testing products and services, and
the continued funding for the development of its ORALscreen product line. In
September and October 2005, the Company executed notes payable with AJW
Partners, LLC, AJW Offshore, Ltd., AJW Qualified Partners, LLC and New
Millennium Capital Partners II, LLC in the total principal amount of $2,000,000
which is payable at maturity in September and October 2008. Interest on these
notes is 8% and is payable quarterly in cash or the Company's common stock at
the option of the Company. The Company issued warrants to purchase 4,000,000
shares of common stock at $.25 per share for five years in connection with these
notes. In addition, the entire principal plus any accrued and unpaid interest
associated with these notes is convertible, at the holder's option, into the
Company's common stock at a conversion price of 65% of the average of the three
lowest intraday trading prices of the common stock for the twenty trading days
preceding the date that the holders elect to convert. A discount to debt
totaling $616,800 ($567,000 for the fair value of the conversion feature of
these notes and $49,800 for the fair value of the warrants issued in connection
with these notes) was recorded during FY2005 and the first quarter of FY2006 and
is being amortized over the term of the notes. The unamortized discount was
$566,548 as of December 31, 2005. Fees of approximately $290,000 incurred in
connection with securing these loans were recorded as a deferred financing
charge. The collateral pledged by the Company to secure these notes includes all
assets of the Company. A liability of approximately $617,000 was recorded for
the fair value of the warrants issued in connection with the $2,000,000 of notes
and the conversion feature which was increased to its market value of
approximately $650,000 at December 31, 2005.
From April to August 2005, the Company executed convertible notes with an
individual in the total principal amount of $650,000 with interest at 10%. Each
note has a maturity date of six months from the date of the note and is payable
in ten monthly installments plus accrued interest commencing on the maturity
date of the note. The Company issued warrants to purchase 650,000 shares of
common stock at $.033 to $.099 per share for three (3) years in connection with
these notes. In addition, the entire principal plus accrued interest associated
with these notes is convertible into the Company's common stock at a conversion
price of the lesser of the closing price of the common stock on the date of the
loan or 85% of the average closing price of the common stock for the five (5)
trading days preceding the notice of conversion. In no event shall the
conversion price be lower than 50% of the closing price of the common stock on
the date of the loan. A discount to debt totaling $172,930 ($156,800 for the
value of the conversion feature of these notes and $16,130 for the value of the
warrants issued in connection with these notes) was recorded during FY2005 and
is being amortized over the term of the notes. The unamortized discount was
$17,063 as of December 31, 2005. A liability of approximately $173,000 was
recorded for the fair value of the warrants issued in connection with the
$650,000 of notes and the conversion feature which was reduced to its market
value of $4,045 at December 31, 2005.
In the April and June 2005, the Company raised net proceeds of
approximately $1,335,000 from the sale of 1,500,000 shares of Series E
Redeemable Convertible Preferred Stock with a face value of $1,500,000 and
Warrants to purchase 150,000 shares of the Company's common stock. The
$1,500,000 of Series E Preferred Stock are convertible into Common Stock at the
lesser of $.08 per share or 80% of the average of the three lowest closing bid
prices for the ten trading days immediately prior to the notice of conversion,
subject to adjustments and limitations, and the Warrants are exercisable at
$.084 per share for a period of three years. The warrants issued in connection
with the sale of 1,500,000 shares of preferred stock and the conversion feature
resulted in a deemed dividend of $1,087,000 being recorded and included in the
earnings per share calculation for the year ended September 30, 2005. A
liability of approximately $1,087,000 was recorded for the original fair value
of the warrants issued in connection with the sale of the 1,500,000 shares of
preferred stock and the conversion feature which was reduced to its market value
of approximately $165,000 at December 31, 2005. As of December 31, 2005, 724,351
shares of this preferred stock had been converted into 36,777,767 shares of
common stock and 775,649 were outstanding. Upon the occurrence of specific
events, the holders of the Series E Redeemable Convertible Preferred Stock are
entitled to redeem these shares under certain provisions of the agreement
covering the purchase of the preferred stock. Accordingly, this security was not
classified as permanent equity.
In December 2004, the Company sold 1,285 shares of Series A Redeemable
Convertible Preferred Stock and Warrants to purchase 600,000 shares of common
stock for which it received net proceeds of approximately $1,160,000. The Series
A Redeemable Convertible Preferred Stock, with a face value of $1,285,000, is
convertible into common stock at the lesser of $.12 per share or 85% of the
average of the three lowest closing bid prices, as reported by Bloomberg, for
the ten trading days immediately prior to the notice of conversion subject to
adjustments and floor prices. The Warrants are exercisable at $.126 per share.
The warrants issued in connection with the sale of 1,285 shares of preferred
stock and the put right and the conversion feature resulted in a deemed dividend
of $1,058,260 being recorded and included in the earnings per share calculation
for the year ended September 30, 2005. A liability of approximately $1,058,260
was recorded for the original fair value of the warrants issued in connection
with the sale of the 1,285 shares of preferred stock and the conversion feature
which was $3,000 at December 31, 2005. As of December 31, 2005, 1,135 shares of
this preferred stock had been converted into 22,607,777 shares of common stock
and the remaining 150 shares of Series A redeemable convertible preferred stock,
with a face value of $150,000, were redeemed by the Company in October 2005 for
$155,415 which included accrued dividends of $5,417.
The cash available at December 31, 2005, the anticipated customer receipts
and the proceeds expected from the last installment of the $3,000,000
convertible note financing are expected to be sufficient to fund the operations
of the Company through April 2006. Beyond that time, the Company will require
significant additional financing from outside sources to fund its operations.
The Company plans to continue working with placement agents and/or investment
fund managers in order to raise additional capital during FY2006 from the sales
of equity and/or debt securities. The investors involved in the September and
October 2005 convertible note financing described above have expressed their
intent to provide an additional $2,000,000 of financing on terms to be
negotiated. The Company plans to use the proceeds from these financings to
provide working capital and capital equipment funding to operate the Company, to
expand the Company's business, to further develop and enhance the ORALscreen
drug screening systems and to pursue the development of in-vitro oral fluid
diagnostic testing products. However, there can be no assurance that these
financings will be achieved. In addition, the Company may consider selling
assets and/or operations, including BJR. However, at the present time, there can
be no assurances that the Company would be successful in these efforts.
Operating revenues are expected to grow during Fiscal 2006 as increasing
number of employers in the United States and overseas convert to using
ORALscreen, Avitar's oral fluid drug testing products. In order to achieve the
revenue growth, the Company will need to increase its direct sales force and
implement an expanded, targeted marketing program. ORALscreen, as an instant
on-site diagnostic test, is part of the fastest growing segment of the
diagnostic test market. Inventories are currently at appropriate levels for
anticipated sales volumes and the Company, with its production capacity and the
arrangements with its current contract manufacturing sources, expects to be able
to maintain inventories at optimal levels. Based on current sales, expense and
cash flow projections, the Company believes that the current level of cash and
cash-equivalents on hand and, most importantly, a portion of the anticipated net
proceeds from the financing mentioned above would be sufficient to fund
operations until the Company achieves profitability. There can be no assurance
that the Company will consummate the above-mentioned financing, or that any or
all of the net proceeds sought thereby will be obtained. Furthermore, there can
be no assurance that the Company will have sufficient resources to achieve the
anticipated growth. Once the Company achieves profitability, the longer-term
cash requirements of the Company to fund operating activities, purchase capital
equipment, expand the existing business and develop new products are expected to
be met by the anticipated cash flow from operations and proceeds from the
financings described above. However, because there can be no assurances that
sales will materialize as forecasted, management will continue to closely
monitor and attempt to control costs at the Company and will continue to
actively seek the needed additional capital.
As a result of the Company's recurring losses from operations and working
capital deficit, the report of its independent registered public accounting firm
relating to the financial statements for Fiscal 2005 contains an explanatory
paragraph expressing substantial doubt about the Company's ability to continue
as a going concern. Such report states that the ultimate outcome of this matter
could not be determined as the date of such report (January 20, 2006). The
Company's plans to address the situation are presented above. However, there are
no assurances that these endeavors will be successful or sufficient.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment"
("SFAS 123R"), which replaces SFAS 123, "Accounting for Stock-Based
Compensation," and supersedes APB Opinion no. 25, "Accounting for Stock Issued
to Employees." SFAS 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial
statements based on their fair values. The effective date for entities that file
as a small business issuer is as of the beginning of the first annual reporting
period that begins on or after December 15, 2005 Therefore, under the current
rules, the Company will be required to adopt SFAS 123R in the first quarter of
fiscal 2007.
Under SFAS 123R, pro forma disclosures previously permitted will no longer
be an alternative to financial statement recognition. The Company must determine
the appropriate fair value model to be used for valuing share-based payments to
employees, the amortization method for compensation cost and the transition
method to be used at the date of adoption. The transition methods include
modified prospective and retrospective adoption options. Additionally, SFAS 123R
clarifies the timing for recognizing compensation expense for awards subject to
acceleration of vesting on retirement and also specifies the treatment of excess
tax benefits associated with stock compensation.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107")
regarding the SEC's interpretation of SFAS 123R and the valuation of share-based
payments for public companies. Avitar is evaluating the requirements of SFAS
123R and SAB 107 and expects that the adoption of SFAS 123R will have a material
impact on Avitar's consolidated results of operations and earnings per share.
The Company has not yet determined the method of adoption or the effect of
adopting SFAS 123R, and it has not determined whether the adoption will result
in amounts that are similar to the current pro forma disclosures under SFAS 123.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs" ("SFAS
151"), an amendment of Accounting Research Bulletin ("ARB") No. 43, Chapter 4,
"Inventory Pricing". SFAS 151 amends previous guidance regarding treatment of
abnormal amounts of idle facility expense, freight, handling costs, and
spoilage. This statement requires that those items be recognized as current
period charges regardless of whether they meet the criterion of "so abnormal"
which was the criterion specified in ARB No. 43. In addition, this Statement
requires that allocation of fixed production overheads to the cost of the
production be based on normal capacity of the production facilities. This
pronouncement is effective for the Company for fiscal periods beginning after
October 1, 2005. The Company is currently evaluating the effect that the
adoption of SFAS 151 will have on its consolidated results of operations and
financial condition, but it is not expected to have a material impact.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154") which replaces APB Opinions No. 20 "Accounting
Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim Financial
Statements" An Amendment of APB Opinion No. 28. SFAS 154 provides guidance on
the accounting for and reporting of accounting changes and error corrections. It
establishes retrospective application, or the latest practicable date, as the
required method for reporting a change in accounting principle and the reporting
of a correction of an error. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005 and
is required to be adopted by Avitar in the first quarter of fiscal 2007. The
Company is currently evaluating the effect that the adoption of SFAS 154 will
have on its consolidated results of operations and financial condition, but does
not expect it will have a material impact.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Except for the historical information contained herein, the matters set
forth herein are "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933, Section 21E of the Securities Exchange Act of
1934 and the Private Securities Litigation Reform Act of 1995. We intend that
such forward-looking statements be subject to the safe harbors created thereby.
Such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievement expressed or implied by such forward-looking statements. Such
factors include, but are not limited to the following: product demand and market
acceptance risks, the effect of economic conditions, results of pending or
future litigation, the impact of competitive products and pricing, product
development and commercialization, technological difficulties, government
regulatory environment and actions, trade environment, capacity and supply
constraints or difficulties, the result of financing efforts, actual purchases
under agreements and the effect of the Company's accounting policies.
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our management, including our chief executive officer and chief financial
officer, have carried out an evaluation of the effectiveness of our disclosure
controls and procedures as of December 31, 2005, pursuant to Exchange Act Rules
13a-15(e) and 15(d)-15(e). Based upon that evaluation, our chief executive
officer and chief financial officer have concluded that as of such date, our
disclosure controls and procedures in place are adequate and effective to ensure
material information and other information requiring disclosure is identified
and communicated on a timely basis.
(b) Changes in Internal Control Over Financial Reporting
During the period covered by this report, we have improved our internal
control over financial reporting by correcting the historical accounting
problems to appropriately account for equity and debt issuances including
freestanding warrants and embedded derivatives. There have been no changes in
our other internal controls over financial reporting that have materially
affected or are reasonably likely to materially affect our internal control over
financial reporting.
PART II OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended December 31, 2005 the Company issued to holders of
the Series E preferred stock 25,458,087 shares of the Company's common stock
upon the conversion of 224,712 shares of their preferred stock. The exemption
for registration of these securities is based upon Section 4(2) of the
Securities Act because the issuances were made to accredited investors in
private placements.
ITEM 6. EXHIBITS
(a) Exhibits:
Exhibit No. Document
3.1 Certificate of Amendment of Certificate of Incorporation previously filed
with the Securities and Exchange Commission on February 13, 2006
(Commission File No. 333-131797), and incorporated herein by reference.
31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
AVITAR, INC.
(Registrant)
Dated: February 14, 2006 /S/ Peter P. Phildius
----------------------------
Peter P. Phildius
Chairman and Chief
Executive Officer
(Principal Executive Officer)
Dated: February 14, 2006 /S/ J.C. Leatherman, Jr.
----------------------------
J.C. Leatherman, Jr.
Chief Financial Officer
(Principal Accounting and
Financial Officer)
EXHIBIT INDEX
Exhibit No. Document
3.1 Certificate of Amendment of Certificate of Incorporation previously filed
with the Securities and Exchange Commission on February 13, 2006
(Commission File No. 333-131797), and incorporated herein by reference.
31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002